More Than Beat Expectations for iPhone Sales, Apple Also Has to Overcome Its Own Past

Apple
AAPL -1.53%
doesn't care about making "the most" devices, so much as it cares about making "the best" ones.

Apple proved there is still demand for its iPhone in the face of stiff competition, selling five million more iphones than expected. So why is its market-share gains stalling? Heard on the Street's Rolfe Winkler joins us with his take. Photo: Apple.

That philosophy, as reiterated by Apple chief
Tim Cook
at a May conference, is worth keeping in mind as investors cheer the company's results for the fiscal quarter ended in June. Those showed Apple sold five million more iPhones than expected, at 31.2 million.

Even so, Apple's smartphone market-share gains have stalled. That may not be such a concern given that focus on making "the best" devices. But it does raise a potentially troubling question: What if the iPhone and iPad go the way of the Mac?

That sounds crazy. But the history of handsets, never mind the Mac, shows that dominance doesn't last long. See Palm,
BlackBerry
and
Nokia.

A revolutionary product when released, the Mac was undercut by a wave of cheap, lower-quality personal computers running
Microsoft
Windows. In 2012, Apple's line of personal computers was still the best on the market, but it had just 5% global market share by units shipped, estimates Gartner.

The iPhone redefined smartphones while the iPad created a whole new computer category, but a similar dynamic is playing out for both. Cheaper devices running
Google's
Android mobile operating system now dominate in smartphones, with 69% share in 2012, compared with 19% for the iPhone, according to research firm Strategy Analytics. In tablets, it says Apple's market share halved to 39% in 2012 from 79% in 2010, when the iPad was released. Android's share leapt to 59% from 20%.

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What will Apple's business look like if, by 2017, it has just 5% market share in tablets and smartphones? Both markets are still growing rapidly. Even so, Apple's business would be much smaller. Using Strategy Analytics' forecast for overall shipments, 5% of the 2017 tablet market would work out to 21 million iPads sold, a third of the number sold in 2012. In smartphones, the figure would be 68 million, half of the number sold in 2012.

Another concern is price and margin pressure that will be exerted by a flood of cheap rivals. Prices for both the iPhone and iPad are falling. And margins may follow: Today Apple makes roughly 40% operating-profit margin on iPhones, estimates analyst
Toni Sacconaghi
of Bernstein. That is versus his estimate of 15% to 20% for Macs. IPad margins are already similar to the Mac, he says.

A key to having the best computer products is the amount of software that is written for them. And, over time, software developers will naturally focus on devices with the most market share—just as they did with Windows-based PCs.

So it is smart for Apple to release cheaper versions of its products, like the iPad Mini, and a lower-end iPhone anticipated later this year. That should prevent its market share ever falling quite so far as the Mac's. And Apple's current products should command a bigger share of the market than the Mac given the early lead in terms of software developed for its mobile platform. Meanwhile, it will help that smartphone purchases are being driven more by consumers than companies.

Apple can probably avoid a Mac rerun. Still, market share will matter. And the long-term threat of Android is probably more serious than Apple shares currently reflect.